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Sanctions On Iran May Send Oil Prices Above $90 Next Year

According to Bank of America Merrill Lynch, oil prices will hit $90 a barrel by the second quarter of 2019, as Iranian oil barrels are removed from the market and other supply disruption risks threaten the tightening oil market.

The United States signaled this week that it would look to take as much Iranian oil as possible out of the market with the renewed sanctions on Tehran.

Although Saudi Arabia and Russia had OPEC and allies pledge last week to ease compliance rates, in other words to boost production by an unspecified number, production increases will make the global spare capacity thinner at a time of low inventories, setting the stage for higher oil prices in case of additional supply disruptions, analysts believe.

“We are in a very attractive oil price environment and our house view is that oil will hit $90 by the end of the second quarter of next year,” Hootan Yazhari, head of frontier markets equity research at Bank of America Merrill Lynch, told CNBC.

“We are moving into an environment where supply disruptions are visible all over the world… and of course President Trump has been pretty active in trying to isolate Iran and getting U.S. allies not to purchase oil from Iran,” Yazhari noted.

Even before OPEC’s much-talked-about meeting last week, the International Energy Agency (IEA) expected—like many analysts—that there would be some sort of production increase. But even if the Iran and Venezuela supply gap is to be plugged, “the market will be finely balanced next year, and vulnerable to prices rising higher in the event of further disruption,” the Paris-based agency said in its Oil Market Report in mid-June.

OPEC has lost around 900,000 bpd in production since September, with Venezuela accounting for about two-thirds of that, Michael Haigh, Managing Director and Global Head of Commodities Research at Societe Generale, told Bloomberg this week.

The meaningful spare capacity in the world is in just four countries—OPEC’s Saudi Arabia, the UAE, and Kuwait, and non-OPEC’s Russia, according to Haigh. While Saudi Arabia claims that it has 2 million bpd of spare capacity, SocGen thinks that it’s more like 1.4 million bpd-1.5 million bpd. Kuwait and the UAE combined probably have another 400,000 bpd, and Russia around 300,000 bpd.

Inventories are now low and spare capacity is declining, Haigh says.

Future Iranian oil supply may have been the leading theme in oil markets this week, but Venezuela’s production continues to crumble, with SocGen estimating that it would drop by another 300,000 bpd between now and OPEC’s next regular meeting in early December 2018.

Moreover, renewed tension in Libya is threatening to turn into yet another meaningful oil supply disruption. Amid low inventories and sparse spare capacity as Saudis and Russians boost production, another supply shock would not be well received, analysts say.

“Earlier this week, Trump Administration officials confirmed that they basically want to take all Iranian exports off the market. This raises the prospect of an even higher Q4 2018 loss than 700,000. With Saudi pledging a million, there will be little spare capacity to deal with any additional outages,” according to Helima Croft, managing director and global head of commodity strategy, global research at RBC Capital Markets and an Atlantic Council board director. Related: U.S. Oil Exports Overtake OPEC’s Number 3

Croft told CNBC this week that the U.S. sanctions on Iran are “incredibly coercive” and that more than 1 million bpd of Iranian oil would be taken out of the market.

“For any corporate that wants to do business in the United States, they will drop their ties with Iran,” she said.

Saudis and Russians may be boosting production, but the risk is that “we cannot afford another supply disruption if we have such thin spare capacity shock absorbers,” Croft noted.

The key question for the oil market going forward will not be how much Russia and the Saudis—and the close Saudi allies such as the UAE and Kuwait—will pump to plug supply losses, but how much spare capacity this would leave to absorb additional supply disruptions.

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The projection by the Bank of America Merrill Lynch that oil prices could hit $90 next year will not be due to a decline in Iranian oil exports as a result of the US sanctions but to the positive fundamentals of the global oil market for this year and next year.

President Trump’s request to Saudi Arabia to raise its production by 2 million barrels a day (mbd) was motivated by two factors. The first is a psychological warfare aimed at promoting the impression that US sanctions will lead to a decline of Iran’s oil exports by 1 mbd. The other is that there will be midterm elections in November this year and he did not want high oil prices to undo the economic boost from his tax cuts thus leading to losses by his Republican party. These two factors have everything to do with politics and nothing to do with economics.

And contrary to assumptions by the Bank of America and many analysts, Iran will not lose a single barrel from its oil exports as a result of the sanctions. Iran’s trump card is the petro-yuan which has virtually nullified the effectiveness of US sanctions. Major customers like the European Union (EU), China, India, Turkey, Russia and Japan are still committed to continue importing Iranian crude.

By lifting its oil production in response to President Trump’s request, Saudi Arabia will be working against its interests’ and the interests of OPEC members who all need an oil price far higher than $80 a barrel to balance their budgets.

Moreover, it is a myth that Saudi Arabia can raise its oil production by 1 mbd let alone 2 mbd. Saudi claim that it can produce at least 12.5 mbd if needed doesn’t stand scrutiny. Saudi Arabia’s production never exceeded 10.4 mbd before with almost a million barrels of which came not from actual production but from stored crude oil on tankers and on land. Saudi Arabia is only able to raise its oil production by 400,000 b/d being the amount it cut under the OPEC/non-OPEC production agreement. Furthermore, Saudi Arabia’s claim that it has a spare production capacity of 2 mbd is highly questionable.

OPEC’s promise of restoring 1 mbd to the market will in effect translate into less than 600,000 barrels a day (b/d).

And despite current outages in Venezuela, Libya, Nigeria and Canada, the global oil market has not re-balanced completely. There is still a small glut in the market capable of taking care of the these outages.

Is it not strange that until President Trump asked Saudi Arabia three weeks ago to raise its oil production in anticipation of a fallout in Iranian oil exports as a result of the sanctions, nobody not even the Saudi oil minister, Mr Khalid Al-Falih spoke about a supply gap in the oil market. Since then, all and sundry have started taking about it.

It is obvious that President Trump’s motivation is political and it doesn’t reflect the realities in the market.

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